Banking within tighter limits

9-2-2010 | Economic news

The credit crisis has left deep marks in society. Governments that bailed out banks have now come to the clear realisation that they should not inflict this on ‘the taxpayer’ too frequently. Confidence in the stability of the financial sector has been damaged and as a result people are diligently looking for measures that can prevent a new banking crisis. Rabobank Chief Financial Officer Bert Bruggink shares his view.

This has led to the current deluge of proposals for reform. US President Obama has proposed not allowing banks that raise savings which fall under guarantees to conduct risky investment banking-related activities. Or, to put it in everyday language, you aren’t allowed to gamble with deposited savings. A number of bankers put forward a case at Davos for establishing funds from which the support for banks facing near or imminent collapse could be paid in future. The worldwide tax that (primarily) banks would have to pay resembles Obama’s proposed bank tax in the US.

Basel 3

There are also new proposals from Basel that have been prepared by the Committee on Banking Supervision and that can be implemented in 2012. From now on Basel only wants to take ‘actual capital’ into consideration when assessing a bank’s capital. Hybrid forms of capital, deferred taxes and minority stakes would consequently no longer be included. Equity investments in insurance companies would therefore have to be deducted from the regulatory capital. The capital requirements for trading positions and structured products will also be increased further. Banks will have to build up additional buffers during prosperous periods.

The banks will furthermore be required to meet a minimum debt-to-equity ratio, i.e. the leverage ratio, meaning the degree to which the leverage of the capital may be utilised. With respect to liquidity, more stringent requirements will be placed on the amount and quality of the investments to be held. There will likewise be stricter requirements vis-à-vis the maturity and quality of the funding to be employed for financing long-term and less liquid assets. These matters will have far-reaching impacts, also for our organisation.

Piling up proposals

What is our view of the above developments? With respect to the first two proposals, we can partially support Obama’s idea of separating traditional banking from the more speculative investment banking. It is, however, imperative to make the emphatic comment in this regard that banks that raise savings must still be able to carry out at least some investment banking-related activities. If, for example, they are dependent upon long-funding (as in the case of Rabobank), a treasury-related activity would still be appropriate. It is also impossible to operate on an exclusively customer-focused basis in the trading environment. You have to help make the market yourself and as a bank you consequently also have to take positions. This can, however, be restricted through limits.

I do not think that the plan for establishing a fund through a bank tax is as well-considered. It raises a number of questions. I cannot, in any case, see how it would prevent moral hazard (running risk at the expense of others) and why Rabobank should help pay for it.

Of all the proposals, the ones from Basel must be taken the most seriously. The related problem is that Basel is piling up a range of proposals that are individually defensible. This results in banks being required to devote a tremendous amount of effort to strengthening their position with respect to solvency and liquidity. This will come at the expense of the scope they (thought they) have at their disposal to fulfil their traditional role. If these proposals become generally accepted in full in Europe, they will act as an additional brake on the economic recovery. I use the term additional brake because governments that have to put their finances in order also necessarily have a braking effect.

Challenge

While Basel’s proposals might not turn out to be as extreme in reality as they appear at present (and timing will be key), it is still reasonable to expect that the regulations will on balance be made more stringent. This will also make it more difficult for Rabobank to carry out its traditional role of credit provider. It will mean Rabobank will either be unable or virtually unable to expand its credit lending in the years ahead.

Banking within increasingly tighter limits furthermore means we will have to re-evaluate the reality level of the Strategic Framework. The management bodies within our Group will be faced with the challenge of bringing the ambitions and opportunities closer together.

Bert Bruggink, Chief Financial Officer Rabobank Group